The Multi-Step Income Statement

The multi-step income statement includes multiple sub-totals within the income statement. This layout makes it easier for readers to aggregate selected types of information within the report. The usual subtotals are for the gross margin, operating expenses, and other income, which allow readers to determine how much the company earns just from its manufacturing activities (the gross margin), what it spends on supporting operations (the operating expense total) and what component of its results do not relate to its core activities (the other income total).

Given its higher level of information content, the multi-step format is usually preferred over the single step format (which does not incorporate sub-totals and so can be more difficult to read).

However, the multi-step approach can still yield misleading results if management alters where expenses are recorded in the statement. For example, an expense may be shifted out of the cost of goods sold area and into the operating expenses area, resulting in a presumed improvement in the gross margin. This is a particularly pernicious problem when multi-step income statements are being compared across multiple periods, and the method of statement compilation is being altered within the presented periods. In this case, a reader might draw incorrect conclusions from the altered presentation of information.

It is possible that management could deliberately shift expenses out of the cost of goods sold category and into operating expenses in order to falsely imply an improvement in gross margins. This could be considered a form of financial statement fraud, and can only be perpetrated when the multi-step format is used, since readers are focusing on the content of the presented subtotals.